K.K. Raman is an Associate Professor of Accounting at North Texas State University. Sharon H. Garrison is an Assistant Professor of Finance at North Texas State University

Garrison, Sharon H.

Raman, K.K.

English

Georgia Southern University: Digital Commons@Georgia Southern

Southern Business Review Volume 11 Issue 2 Article 5 Underfunded Public Employee Pension Plans: Scope of the Problem in the South and Southwest K.K. Raman North Texas State University Sharon H. Garrison North Texas State University Follow this and additional works at: https://digitalcommons.georgiasouthern.edu/sbr  Part of the Business Commons, and the Education Commons Recommended Citation Raman, K.K. and Garrison, Sharon H. () "Underfunded Public Employee Pension Plans: Scope of the Problem in the South and Southwest," Southern Business Review: Vol. 11: Iss. 2, Article 5. Available at: https://digitalcommons.georgiasouthern.edu/sbr/vol11/iss2/5 This article is brought to you for free and open access by the Journals at Digital Commons@Georgia Southern. It has been accepted for inclusion in Southern Business Review by an authorized administrator of Digital Commons@Georgia Southern. For more information, please contact digitalcommons@georgiasouthern.edu. UNDERFUNDED PUBLIC EMPLOYEE PENSION PLANS: SCOPE OF Tl-IE PROBLEM IN THE SOUTH AND SOUTHWEST K.K. Raman and Sharon H. Garrison The objective of this article is to ,hcd some light on the problem of under-funded State and local government employee pen~ion plans. In particular, we examine the underfunding stallls of State-local pen~ion plans in the South and Southwest relative to the rest of the United States. State and local government pension plan~ arc exempt from the funding and other major rrovi5ions of the Employee Rctirl·rncnt Income Security Act of 1974 (ERISA). Perhaps for thi, reason, many State and local government pension plans are not setting aside sufficient fund~ to provide for estimated future benefits. In a survey of 72 go,ernmcntal pension plans, the General Accounting Office (GAO, 1979) found that billions of dollars in unfunded liabilitie, had been accumulated, and that 53 of thc~e plam ,,ere not recei1-ing large enough contributions to satisfy the funding standards of ERISA. The GAO reported that compliance ,,ith ERIS/\ ,,ould require annual con-tributions in many plans to more than double. Also, the Advisory Commis-sion on Intergovernmental Relations (ACI R, 1980) reported that the average asset-to-accrued liability ratio for all State-local plan, 11 as in the -15 10 50 percent range, and that many individual State and local retirement s},tcm1 appeared to be facing potentially ~erious funding problem,. It could be argued that full funding of public pension~ is unnecessary, since governments have perpetual life and the po1,er to tax. Yet, a, Tilo\C~ (1976) points out. governmental units arc hedged in by ,tatutory lirni1' on ta,ation and debt, and in the event of a taxpayer's re\olt or a ~eriou~ disloeation in the economy, may find it impossible to finance their pension plans. Morco1cr. if it is difficult to appropriate enough money to adequately fund pemion plans now, why should it be any easier in the future? Tilme ,uggem that funding may be ncce~~ary for the sake of se.:urity ;111d to n:a"urc the beneficiaries. Interestingly. Ehrenberg and Smith ( 1981 l report that public employees perceive u nfunded pension promises a\ being quite risky and de-mand some degree of compemation in the form of higher \\ages for the ris~ that comes from underfunding. The underfunding of State-loeal pensions is aho an important public policy issue, since underfunding may lead to intergenerational inequities if a future generation of taxpayers have to pay for these liabilities. In a competitive po· litical environment, it may be only too tempting for public officiab to in-crease their reelection chances by promising employees liberal pension benefits without having to raise eurrcnt taxes. II has also been \Uggcstcd by Feldstein and Seligman (1981) that underfunded pensions may result in lower nation-al savings and capital accumulation if employees reduce rheir savings in an-ticipation of receiving pension benefits. 20 Accounting for Pcm,ion Costs The State-local pension underfunding problem may have been aggravated by the fact that , unlike corporate accounting. State-local_ government acco~nt-ing is not subject to Securities and Exchange Comm1_ss1on (SEC) regulation. Under the U.S. Constitution, the States are the sovereign and superior govern-mental entities for the geographic area, they encompa~~. The State, thu~ pm-sess the legal authority to prescribe accounting practices for t hemseh e, and for local governments. A recent survey by the Council of State Governments (C0SG, 1980) reported many departures from GAAP (generally accepted accounting principles) in State accounting and reporting practices. In par-ticular, it reported that only 28 State, determine their pen~ion costs on an actuarial basis. while the remaining 22 States are on a pay-as-you-go basi~. Pay-as-you-go basis implies that annual appropriations arc sufficient just to meet the pension plan's current benefit payments. Deficiencies in account-ing and reporting practices also exist for local governments. In a recent sur-vey. Engmom ( 1984) found that only 59 percent of a sample of dtie~ possessing the MFOA Certifil.:ate of Conformance reported the amount of unfunded pension obligations. f 11 Only a tiny fraction of all the go, em men-tal units in the U.S. possess the MFOA Certificate. Detailed e~timates of unfunded pension liabilities for most governmental unit, is generally not avail-able except in two or three ~tatc, (e.g., Pennsylvania) where local go,ern-me1m are required 10 report ~uch information by the Staie government. Given the unavailability of data on unfunded pension liabilitie~ . ...,e uti-lized two financial ratio~ that are considered to be correlates of pension fund underfunding. Information on these ratio, are a,·ailable from the Bureau of Ccn~u,. Our objective \\a, to l!xamine the underfunding , tatu, of State-local pcn~ion plan~ in the South and Soutll\\e~t relative to the rest of the country. [he• Stud, In a report on citic~ in financial di~tre,~. the ,\CIR (1973) indicated that iwo financial ratios for pension plam may be helpful in e, aluating the ex-lent of underfunding. The,e, ariable, are I) the ratio of current pension fund assets to current annual pension fund benefit payment\ (PAPB), and 2) the ratio of current annual pension fund contributions to current annual pen-\ion fund henefit paymenh (PCPB). The ACIR ,ugge,ted that a ,ubstantial deviation in these ratios from the national average, may indicate a ~eriom underfunding problem. Subsequently. Ehrenberg ( 1980) developed a t heoretieal model of a public sector retirement sy~tern. Thi\ model seeh to measure the degree of pen,ion fund underfunding as a function of a number of "ob,enable correlates" ~hat can be computed for retirement system~. Ehrenberg reports that hi, model is robust and that in hi~ own and other empirical research on public sector l~bor markets, these correlates "perform" a~ satisfactory proxies for pen-sion underfunding. Two of these observable correlates are financial ratios - PAPB and PCPll. 21 As stated earlier, data on unfunded pen~ion liahilitics for most State-local governments arc not available. However, data required to calculate the ra-tios PAPB and PCPB arc available from the Bureau of Census' 1982 Cen-sus of Governments. These data arc available for plans administered by local governments and for State administered plans rat her than just for State em-ployees. While data for State employees only "ould have been preferable, 1 they are simply not available. However, there are two advantages to the data for State administered plans. The first is that State administered plans con-tain about 90 percent of all State and local pension participants (ACIR, 1980. p.7) and thus are more comprehensive than locally administered plans which , may include only a \mall fraction of local employee~. The ,econd advantage is that reporting and disclo,ure requirements for State administered plans are extensive and hence data ma} be more reliable (ACI R, 1980, p.7). Also, local government officials belie11e that if the States were to mandate funding and other reforms, the States should also pay for these reforms (GAO, 1979, p.35). Hence, the State\ may be ~aid to bear ultimate re,ponsibility for the 1 fiscal heahh of State admini,tercd plans. The Bureau of Census divide~ the South and Southwest into three geo-graphic regions - We,t South Central (consi,ting of Oklahoma, Texas, Loui-siana, and Arkansas), East South Central (consisting of Kentucky, Tennessee, Mis\is\ippi and Alabama}, and South Atlantic (consisting of Delaware. Maryland, \\'est Virginia. Virginia, North Carolina, South Carolina, Geor-gia and Florida). Table-I presents the U.S. and regional 11alues for the 111,0 pen,ion ratios. Based on the U.S. average~. State administered plans appear to be in better financial shape than plans administered by local governments. (Note that the higher the ratios, the bener the lunding position.} This is gener-ally to be expected, since States typically ha\e better acce,s to resources than local governments. State administered plans in the three regions appear to be as "ell funded (or underfunded) as the national average. However, plans administered by local government, in the three regions appear to be in a bet-ter po,ition than ,imilar plam elsewhere. Thi'> may reflect the less generous pension benefit, in the South and Southwest, as well as the greater financial strength (and fiscal conservatism) of these local governments. Nevertheless, it \'.ould appear that unfunded pension liabilities are as much a fact of life in the South and Southv.est as in other parts of the country. We aho utilized an alternate methodology ror estimating the burden of underlunded pensions in the South and Southwest. Recently, Mark~ and Ra-man (I 984) investigated the following model: F = a0 · (PAPB/1 · (PCPB)a2 In the above model, the independent ,ariables PAPB and PCPB have been shown by Ehrenberg ( 1980) to be theoretical correlates of pension under• funding. The dependent variable r is a direct measure of underfunding. Since the amount of underfunding may be expected to be associated with the size 22 TABLE l pension Ratios: U.S. and Regional Averages A, Pension Plans Administered by State Governments West South Central *PAPB 14. 34 12.02 PCPB 2.82 2.70 8. Pension Plans Administered by Local Governments We st South u .s. Central *PAPB 10. 83 12.28 PCPB 2.30 3. 14 East South Central 14. 33 3.1 2 East So uth Central 12-07 2.98 South Atlantic 13. 42 2. 78 south Atlantic 11. 72 2.49 *PAPB - Ratio of current pension fund assets to current annual pension Eund benefit payments PCPB - Ratio of current annual pension fund contributions to current annual pension fund benefit payments 23 of the govcrnmcn1al unit, the dependent ,ariable Fis the amount of unfunded pension liabilities scaled by pormlation. (21 l\lark, and Raman (1984) esti-mated the model using data from the Act 293 Report of the Public Employee Retirement Study Commission of the State of Penmylvania. This Act re-quire~ the commis,ion to collect certain financial data (im:luding unfunded obligations) for all the public employee pemion plan~ in Pennsylvania (31. Although the mo<lel is non-linear, it \,a, eMimatcd by ordinary least-squares (OLS) regression analysis after recasting the equation in the log-linear form (tal-ing the natural logarithm of both side~ of the equation). While the R· did not exceed 0.33, both \'ariabk, l',\PB an<l l'CPB and the comtant (aO) , \\ere statistically significant. Assumption~ of OLS regression, i.e., homoscedasticity and normality of residuals were ,atisfied. In this article we me the estimates of the con\tant (a0) and the coefficients of PAPB and PCPB to measure the amount of unfunded pensions liabilities per capita. These es-timates are reported in Tablc-2. The national average is $9.36 per capita for State admini,tered plans and $ I I. 7-l for locally admini5tered plans. There is considerable \ariation in the e~timated per capita burden among the differ• ent State, in the South and Southwest. Note that the per capita estimate of unfunded pensions for State admini'>!ered plan~ will he borne by all residents of the State, 1, hik the per capita c,timate for locally admini,tered plam will be borne by resident\ of only tho,e loL·al go~crnment ,. Summar) and Condm,ions There is 50rnc evidence: (GAO, 1979: /\CIR, 1980) that public c:rnployee pcn,ion plam arc seriously undcrfunde<l. Unfunded pcn,ions rai~e irnpor• tam public policy is~ues in term\ of intergenerational equities (Tilove, 1976) and the impact on national savings (Fcld5tein and Seligman, 1981 ). Morc01er, since unfunded obligation~ represent potential claims on the ca,h flows of the governmental unic, they may be expected to have an impact on propert) values (Epple and Schipper, 1980) and creditor decision, (r-.1,irl-, and Ra• man. 1985). Since State-local government accounting is not ~ubject to Securities and Exchange Commission (SEC) regulation, detailed estimates of unfunded lia-bilities for State-local governrno;:nt, is generally not available. We therefore relied on a theoretical model by Ehrenberg (1980) to ,elect two financial ra· cios that arc "correlaces" of underfunding. Thc~c correlate, \\ere used to estimate the: burden of underfunding in the South and Southwo;:st. On aver· age, the underfunded pen~ion liability problem seem, to he as severe in the South and the Southwest as in the rest of the U.S., though there are con-~iderable \ariations among the.: State~ in the region. Howc\\:r, lon1lly ad· ministered plam in the South anJ Southwest generally appear to be in a stronger position than similar plan~ elsewhere, reflecting perhaps the great· er financ:ial strength (and fi~cal conso;:rvatism) of these local governments. 24 -TABLE 2 Model Estimates of Unfunded Pension Liabilities Per Capita State Locally Administered Administered Plans Plans United States s 9 . 36 $11. 74 West South Central 10.47 9.81 Oklahoma 10. 56 7.28 Texas 9 . 19 8. 50 Louisiana l 5. 31 15. 34 Arkansas 8 . 70 13. 00 East South Central 9.04 10.08 Kentucky 10. 32 8.92 Tennessee 8.43 10.27 Mississippi 9.33 18. 20 Alabama 8.40 9.26 South Atlantic 9.76 10.93 Delaware 7 .4 7 18.67 ~aryland 13. 01 9.37 West Virginia 1 7 . 21 22.48 Viq inia 10.76 9.39 North Carolina 8.90 7 . 57 South Carolina 7.80 8.86 Georgia 9.03 16 . 28 Florida 8 . 59 13. 32 25 I FOOTNOTES [I.) The Municipal Finance Officers Association (MFOA) has a voluntary program for compliance with generally accepted accounting principles ' (GAAP). Governmental units meeting most of the GAAP requirements are awarded the Certificate of Conformance. (2.) We believe that this is an approprate way of calculating the burden or unfunded pensions. The literature on municipal bonds (Lamb and Rap. paport, 1980; PSA, 1981), for example, states that bonded debt per capita is an important variable in general obligation credit analysis. While unfunded pension liabilities are not bonded debt, they do represent potential claim, on the future ca~h flow\ of the governmen• ta! unit. [3.) The importance of Pennsylvania's Act 293 data has been demonstrat• ed by Ehrenberg and Smith ( 1981) and Epple and Schipper (1981) in the context of research in the labor and housing markets, respectively. REFERl:NCES I. Advisory Commission on Intergovernmental Relations, Cicy Financial Emergencies (ACIR, 1973). 2. _ _ __ , Stace and Local Pension Sysce,m (ACIR, 1980). 3. Council of State Governments, inventory of Current State Go~ernmenr Accounting and Reporting Practi~·es (COSG. I 980). 4. Ehrenberg, R., "Correlates of Underfunding of Public Sector Retire• ment Systems", Economic Inquiry (July, 1980). pp. 493-500. 5. _ _ __ and R. Smith, "A Frame"or~ for Evaluating State and Local Government Pension Reform'', in P. Miestkowski and G. Peter· son, Public Sector Labor Markecs (The Urban Institute, 1981). 6. Engstrom, J., ··remion Reporting by Municipalities," Journal of A•·· counting, Audicing and Finance (Spring 1984). pp. 197-211. 7. Epple. D. and K. Schipper, "Municipal Pension Funding: A Theory and Some Evidence," Public Choice (1981). pp. 141 -178. 8. Fekbtein, M. and S. Seligman, "Pen,ion Funding, Share Prices and National Savings," Journal of Finance (September 1981 ). pp. 801-824. 9. General Accounting Office, Funding of State and Local Government Pension Plans: A Nacional Problem (GAO, 1979). 10. Mark,, B. and K. Raman, "Pension Ratios A~ 'Correlate~· of Municipal Pension Underfunding", (Unpublishl!d paper, I 984). 26 11. Marks, B. and K. Raman. "The Importance of Pension Daia for Municipal and State Creditor Deci~ions," Journal of Accounting Research (forthcoming, I 985). 12. Tilove, R., Public Employee Pension Funds (Columbia University Press, 1976). K.K. Raman is an Associate Professor of Accounting at North Texa~ State University. Sharon H. Garrison is an Assistant Professor of Finance at Norch Texas State University. 27 

Underfunded Public Employee Pension Plans: Scope of the Problem in the South and Southwest

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Underfunded Public Employee Pension Plans: Scope of the Problem in the South and Southwest

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